PEC Ltd - Losses from associates and JVs (OCBC)

Maintain BUY

Previous Rating: BUY

Current Price: S$0.835

Fair Value: S$1.12

4Q results disappoint. PEC Ltd ("PEC") reported a weak set of 4Q and FY11 results. 4Q revenue and net profit fell by 19% and 64% to S$101m and S$3.5m respectively. FY11 revenue came in at S$407m, in line with our expectations. However, net profit fell 24% YoY to S$32m, 20% shy of our estimates. This was mainly due to an unexpected S$6.7m of losses from associates and JVs in 4Q, which had wiped out gains from the previous three quarters. The company's gross margin improved to 27.8% in FY11 (FY10: 26.4%). The company also announced dividends of 3.0 cents per share.

Segmental gross margins mixed. On a segmental level, FY11 gross margin for project works improved to 31.5% (FY10: 27.5%), while margin for maintenance services decreased to 17.8% (FY10: 23.4%). We are deeply concerned over the steep fall in maintenance margin as the segment typically represents the most stable revenue stream. Looking forward, we feel that intensifying competition may result in further margin contraction.

Let down by losses from associates and JVs. The S$6.7m of losses from associates and JVs relate mainly to unconfirmed claims arising from variation works which have been carried out during the financial year. These variation works led to higher costs for which financial settlement from clients was not yet concluded. To this end, the management said that it is negotiating with the clients and hope to reach a settlement soon.

S$91m surplus cash. PEC's balance sheet remained very strong with S$159m in cash and S$0.9m in debt. We estimate that the company would require no more than S$52m of cash for its normal operations (including working capital and capex) in FY12. We further estimate that the company has surplus cash of S$91m. (See Exhibits 2 and 3). This surplus cash provide the company with the flexibility to seek strategic acquisitions or joint ventures when such opportunities arise.

Uncertain outlook. Given the uncertainty in Europe and United States, operating environment for the company has turned more challenging. Against this backdrop, the company's improved order book of S$300m provides some earnings stability over the near term. We have also switched to SOTP valuation (from PER) to reflect the strength of the company's cash position and obtained a fair value estimate of S$1.12 (versus S$1.23 previously). (See Exhibit 4) Maintain BUY.